[Federal Register Volume 78, Number 135 (Monday, July 15, 2013)]
[Notices]
[Pages 42132-42135]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-16818]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-69948; File No. SR-CBOE-2013-041]
Self-Regulatory Organizations; Chicago Board Options Exchange,
Incorporated; Order Approving a Proposed Rule Change, as Modified by
Amendment Nos. 1 and 2, To Amend Rule 6.53(u), Relating to Qualified
Contingent Cross Orders
July 9, 2013.
I. Introduction
On March 28, 2013, the Chicago Board Options Exchange, Incorporated
[[Page 42133]]
(``Exchange'' or ``CBOE'') filed with the Securities and Exchange
Commission (``Commission''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to amend CBOE Rule 6.53(u) to
allow Qualified Contingent Cross (``QCC'') Orders with more than one
option leg to be entered in $0.01 increments. The proposed rule change
was published for comment in the Federal Register on April 16, 2013.\3\
CBOE filed Amendment No. 1 to the proposal on April 18, 2013.\4\ CBOE
filed Amendment No. 2 to the proposal on May 29, 2013.\5\ On June 5,
2013, the Commission published notice of and solicited comment on the
proposed rule change, as modified by Amendment Nos. 1 and 2, and
extended the time period for Commission action on the proposal to July
15, 2013.\6\ The Commission received no comments regarding the
proposal, as amended. This order approves the proposed rule change, as
modified by Amendment Nos. 1 and 2.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 69360 (April 10,
2013), 78 FR 22591.
\4\ In Amendment No. 1, CBOE added an additional paragraph at
the end of the purpose section stating that: (1) A QCC Order with
multiple legs is a form of a complex order and should be able to be
entered in $0.01 increments, as non-QCC complex orders can currently
be entered in $0.01 increments; and (2) such orders still cannot
trade unless they are at or between the NBBO and the opportunity to
trade QCC Orders with multiple legs in $0.01 increments provides an
opportunity for price improvement at this smaller increment level.
The paragraph added in Amendment No. 1 was deleted and replaced by
language added in Amendment No. 2. See note 5 infra.
\5\ In Amendment No. 2, CBOE replaced the paragraph added by
Amendment No. 1 with two paragraphs at the end of the purpose
section stating that: (1) Were it not for language in CBOE Rule
6.53(u) that limits the entry of QCC Orders to the standard
increments applicable to simple orders in the options class of each
leg, QCC Orders with multiple legs would be allowed to be traded in
$0.01 increments under CBOE Rule 6.42; (2) the nature of the pricing
of a complex order, whether a QCC Order or otherwise, is such that
the pricing is based on the relative price of one option versus
another and thus the standard increment of trading of a complex
order's individual options legs is less relevant to the pricing of
the complex order; (3) the proposed amendment to permit QCC Orders
with more than one option leg to be entered in the increments
specified for complex orders under CBOE Rule 6.42 (i.e., $0.01
increments) would put the trading of QCC Orders with multiple legs
on the same footing as the trading of other types of complex orders;
(4) pursuant to CBOE Rule 6.53(u)(ii), each options leg of a complex
QCC Order cannot trade unless each leg provides price improvement
over a public customer order resting in the electronic book and is
at or between the NBBO, and to date, CBOE has never had to reject a
submitted complex QCC Order because it would have violated either of
these principles; and (5) permitting the trading of QCC Orders with
multiple legs in $0.01 increments would provide an opportunity for
price improvement at this smaller increment level.
\6\ See Securities Exchange Act Release No. 69675 (May 30,
2013), 78 FR 33868.
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II. Description of the Proposal
Currently, CBOE Rule 6.53(u) states that QCC Orders may only be
entered in the standard increments applicable to simple orders in the
options class under CBOE Rule 6.42.\7\ CBOE Rule 6.42 provides trading
increments of $0.01, $0.05, or $0.10 for individual option series, and
orders to buy or sell a single option series must be entered in the
trading increment applicable to the series. CBOE Rule 6.42(4) allows
bids and offers on complex orders to be expressed in any increment,
regardless of the minimum increment otherwise applicable to the
individual legs of the complex order. CBOE proposes to amend CBOE Rule
6.53(u) to permit QCC orders with more than one option leg to be
entered in the increments specified for complex orders under CBOE Rule
6.42, i.e., $0.01 increments.\8\
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\7\ A QCC Order is an order to buy (or sell) at least 1,000
standard option contracts or 10,000 mini-option contracts that is
identified as being part of a qualified contingent trade coupled
with a contra-side order to sell (or buy) an equal number of
contracts. A ``qualified contingent trade,'' or ``QCT,'' is a
transaction consisting of two or more component orders, executed as
agent or principal, where: (1) At least one component is an NMS
stock, as defined in Rule 600 of Regulation NMS under the Act; (2)
all components are effected with a product or price contingency that
either has been agreed to by all the respective counterparties or
arranged for by a broker-dealer as principal or agent; (3) the
execution of one component is contingent upon the execution of all
other components at or near the same time; (4) the specific
relationship between the component orders (e.g., the spread between
the prices of the component orders) is determined by the time the
contingent order is placed; (5) the component orders bear a
derivative relationship to one another, represent different classes
of shares of the same issuer, or involve the securities of
participants in mergers or with intentions to merge that have been
announced or cancelled; and (6) the transaction is fully hedged
(without regard to any prior existing position) as a result of other
components of the contingent trade. See CBOE Rule 6.53(u)(i). The
six requirements are substantively identical to the six elements of
a QCT under the Commission's QCT exemption. See Securities Exchange
Act Release Nos. 54389 (August 31, 2006), 71 FR 52829 (September 7,
2006) (``Original QCT Exemption'') and 57620 (April 4, 2008), 73 FR
19271 (April 9, 2008) (``CBOE QCT Exemption''). The current QCT
exemption (i.e., as modified by the CBOE QCT Exemption) is referred
to herein as the ``NMS QCT Exemption.''
\8\ QCC Orders with one option leg would continue to trade in
the standard increment applicable to simple orders in the option
class. See CBOE Rule 6.53(u).
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CBOE believes that, because a QCC Order with multiple option legs
is a form of complex order, these QCC Orders also should be permitted
to be entered in $0.01 increments, a change the Exchange states would
place QCC Orders with multiple options legs on the same footing as
other types of complex orders.\9\ CBOE states that the pricing of a
complex order, whether or not it is a QCC Order, is based on the
relative price of one option leg to another (as opposed to the outright
price of a single option), and therefore that the standard increment of
trading of the individual legs of a complex order is less relevant to
the pricing of the complex order.\10\ In addition, CBOE notes that,
under CBOE Rule 6.53(u)(ii), each option leg of a complex QCC Order
must: (1) Provide price improvement over a public customer order
resting in the electronic book; and (2) be at or between the NBBO.\11\
CBOE also states that it has never had to reject a complex QCC Order
because it would have violated either of these principles.\12\ Finally,
CBOE believes that allowing QCC Orders with multiple options legs to be
entered in $0.01 increments will provide an opportunity for price
improvement at a smaller increment level.\13\
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\9\ See Amendment No. 2.
\10\ See id.
\11\ See id.
\12\ See id.
\13\ See id.
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III. Discussion and Commission Findings
After careful review, the Commission finds that the proposed rule
change, as modified by Amendment Nos. 1 and 2, is consistent with the
requirements of the Act and the rules and regulations thereunder
applicable to a national securities exchange and, in particular, with
Section 6(b) of the Act.\14\ In particular, the Commission finds that
the proposed rule change is consistent with Sections 6(b)(5) \15\ and
6(b)(8),\16\ which require, among other things, that the rules of a
national securities exchange be designed to promote just and equitable
principles of trade, to prevent fraudulent and manipulative acts, to
remove impediments to and perfect the mechanism for a free and open
market and a national market system, and, in general, to protect
investors and the public interest, and that the rules of an exchange do
not impose any burden on competition not necessary or appropriate in
furtherance of the purposes of the Act. In addition, the Commission
finds that the proposed rule change is consistent with Section
11A(a)(1)(C) of the Act,\17\ in which Congress found that it is in the
public
[[Page 42134]]
interest and appropriate for the protection of investors and the
maintenance of fair and orderly markets to assure, among other things,
the economically efficient execution of securities transactions.
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\14\ 15 U.S.C. 78f(b). In approving this proposed rule change,
the Commission has considered the proposed rule's impact on
efficiency, competition, and capital formation. See 15 U.S.C.
78c(f).
\15\ 15 U.S.C. 78f(b)(5).
\16\ 15 U.S.C. 78f(b)(8).
\17\ 15 U.S.C. 78k-1(a)(1)(C).
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In 2011, the Commission approved CBOE's proposal to establish rules
providing for the trading of QCC Orders on CBOE,\18\ which followed the
Commission's approval of a proposal by the International Stock
Exchange, LLC (``ISE'') to trade QCC Orders.\19\ In the ISE Order, the
Commission noted that the parties to a contingent trade are focused on
the spread or ratio between the transaction prices for each of the
component instruments (i.e., the net price of the entire contingent
trade), rather than the absolute price of any single component.\20\
Under the requirements of the NMS QCT Exemption, the spread or ratio
between the relevant instruments must be determined at the time the
order is placed, and this spread or ratio stands regardless of the
market prices of the individual orders at their time of execution.\21\
As the Commission noted in the Original QCT Exemption, ``the difficulty
of maintaining a hedge, and the risk of falling out of hedge, could
dissuade participants from engaging in contingent trades, or at least
raise the cost of such trades.'' \22\ Thus, the Commission found that,
if each stock leg of a qualified contingent trade were required to meet
the trade-though provisions of Rule 611 of Regulation NMS, such trades
could become too risk and costly to be employed successfully and noted
that the elimination or reduction of this trading strategy potentially
could remove liquidity from the market.\23\
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\18\ See Securities Exchange Act Release No. 64653 (June 13,
2011), 76 FR 35491 (June 17, 2011) (order approving CBOE-2011-041)
(``CBOE QCC Approval Order'').
\19\ See Securities Exchange Act Release No. 63955 (February 24,
2011), 76 FR 11533 (March 2, 2011) (order approving ISE-2010-73)
(``ISE Order'').
\20\ See ISE Order at 11540.
\21\ See id. See also supra note 7.
\22\ See Original QCT Exemption at 52831.
\23\ See id.
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CBOE's QCC Orders allow a Trading Permit Holder to cross the
options leg(s) of a qualified contingent trade in a Regulation NMS
stock on CBOE immediately, without exposure, provided that the
requirements of CBOE Rule 6.53(u) are satisfied. In approving CBOE's
proposal, the Commission stated that QCC Orders could facilitate the
execution of qualified contingent trades, which the Commission
previously had found to be beneficial to the market as a whole by
contributing to the efficient functioning of the securities markets and
the price discovery process.\24\ The Commission noted that QCC Orders
would provide assurance to parties to stock-option qualified contingent
trades that their hedge would be maintained by allowing the options
component of the qualified contingent trade to be executed as a clean
cross.\25\
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\24\ See CBOE QCC Approval Order at 35492, citing Original QCT
Exemption, supra note 7.
\25\ See CBOE QCC Approval Order at 35492.
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The CBOE QCC Approval Order stated further that, although the
Commission believed that order exposure is generally beneficial to the
options markets in that it provides an incentive to options market
makers to provide liquidity and therefore plays an important role in
ensuring competition and price discovery in the options markets, the
Commission also has recognized that contingent trades can be ``useful
trading tools for investors and other market participants, particularly
those who trade the securities of issuers involved in mergers,
different classes of shares of the same issuers, convertible
securities, and equity derivatives such as options [italics
added]'',\26\ and that ``[t]hose who engage in contingent trades can
benefit the market as a whole by studying the relationships between
prices of such securities and executing contingent trades when they
believe such relationships are out of line with what they believe to be
fair value.'' \27\ Thus, the Commission believed that transactions that
meet the specified requirements of the NMS QCT Exemption could be of
benefit to the market as a whole, contributing to the efficient
functioning of the securities markets and the price discovery
process.\28\
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\26\ See CBOE QCC Approval Order at 35492, citing Original QCT
Exemption at 52830-31.
\27\ See id.
\28\ See CBOE QCC Approval Order at 35492, citing CBOE QCT
Exemption at 19273.
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In the CBOE QCC Approval Order, the Commission stated that the
benefits provided by the exposure requirement and by qualified
contingent trades, such as QCC Orders, required the Commission to weigh
the relative merits of both for the options markets.\29\ The Commission
found that CBOE's rule, by requiring a QCC Order to be: (1) Part of a
qualified contingent trade under Regulation NMS; (2) for at least 1,000
contracts; (3) executed at a price at or between the NBBO; and (4)
cancelled if there is a public customer order on the electronic book,
struck an appropriate balance for the options markets in that it was
narrowly drawn and established a limited exception to the general
principle of exposure and retained the general principle of customer
priority in the options markets.\30\ The Commission noted, further,
that the requirement that a QCC Order be part of a qualified contingent
trade that satisfies each of the six underlying requirements of the NMS
QCT Exemption, and the requirement that a QCC Order be for a minimum
size of 1,000 contracts, further limited the use of QCC Orders by
ensuring that only transactions of significant size would be able to
avail themselves of the order type.\31\
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\29\ See CBOE QCC Approval Order at 35492.
\30\ See id.
\31\ See CBOE QCC Approval Order at 35492-93. The CBOE QCC
Approval Order also noted CBOE's representation that, to effect
proprietary orders (including QCC Orders) electronically from on the
floor of the Exchange, members must qualify for an exemption from
Section 11(a)(1) of the Act, 15 U.S.C. 78k(a)(1), which concerns
proprietary trading on an exchange by an exchange member. Among
other things and as discussed in greater detail in the CBOE QCC
Approval Order, CBOE recognized that Trading Permit Holders
effecting QCC Orders and relying on the ``G'' exemption for yielding
priority to non-members under Section 11(a)(1)(G) of the Act and
Rule 11a1-1(T) thereunder would be required to yield priority to any
interest, not just public customer orders, in the electronic book at
the same price to ensure that non-member interest is protected. See
CBOE QCC Approval Order at 35493.
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The Commission believes that the analysis in the CBOE QCC Approval
Order applies equally to the current proposal. By allowing QCC Orders
with more than one option leg to trade in $0.01 increments, rather than
in the standard increment applicable to single leg orders in the
options class, the proposal could facilitate the execution of QCC
Orders with multiple option legs by providing additional price points
at which these orders would be able to be executed, which, in turn,
could facilitate the execution of qualified contingent trades. As
discussed above, the Commission previously has found that transactions
that meet the specified requirements of the NMS QCT Exemption could
benefit the market as a whole by contributing to the efficient
functioning of the securities markets and the price discovery process.
Further, as discussed above, QCC Orders provide assurance to the
parties to a stock-option qualified contingent trade that their hedge
will be maintained by allowing the options component of the order to be
executed as a clean cross. By allowing QCC Orders with multiple option
legs to be executed in $0.01 increments, the proposal could further
facilitate the execution of the option component of a stock-option
qualified contingent trade.
The Commission notes that CBOE Rule 6.53(u) will continue to
require that QCC Orders, including those with
[[Page 42135]]
multiple option legs, be: (1) Part of a qualified contingent trade
under Regulation NMS; (2) for at least 1,000 standard option contracts;
\32\ (3) executed at a price at or between the NBBO; and (4) cancelled
if there is a public customer order at the same price resting on the
electronic book. Thus, the Commission believes that the proposal
continues to strike an appropriate balance for the options market in
that it is narrowly drawn and in that it establishes a limited
exception to the general principle of exposure and retains the general
principle of customer priority in the options markets.\33\
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\32\ For mini-option contracts, the minimum size is 10,000
contracts. See CBOE Rule 6.53(u).
\33\ See CBOE QCC Approval Order at 35492.
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For the foregoing reasons, the Commission finds that the proposed
rule change is consistent with Section 6(b)(5) \34\ and 6(b)(8) \35\ of
the Act. Further, the Commission finds that the proposed rule change is
consistent with Section 11A(a)(1)(C) of the Act.\36\
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\34\ 15 U.S.C. 78f(b)(5).
\35\ 15 U.S.C. 78f(b)(8).
\36\ 15 U.S.C. 78k-1(a)(1)(C).
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IV. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\37\ that the proposed rule change (SR-CBOE-2013-041), as modified
by Amendment Nos. 1 and 2, is approved.
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\37\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\38\
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\38\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2013-16818 Filed 7-12-13; 8:45 am]
BILLING CODE 8011-01-P